4 Factors that Affect the Current Prime Rate

The current prime rate is a very important number in the lending industry. It is the rate of interest charged by commercial lenders to large corporations, and many other loan products are tied to this rate. Therefore, if you plan on borrowing in the future, you should understand these factors that affect the current prime rate.

1. Default Rates

One thing that can drastically affect the current prime rate is the number of defaults that are in the market. If there are many defaults, the Federal Reserve may be encouraged to lower the prime rate. When interest rates are high and mortgages default, this hurts the nation's banks because they have to repay the obligations at that rate. Lowering the prime rate will help banks and help more lenders avoid defaulting on their loans. 

2. Inflation

Inflation is importantly related to the current prime rate. The Federal Reserve knows that the rate that it gives out directly affects inflation. By keeping interest rates low, the Federal Reserve can do its part to keep inflation low. If consumers can get a better rate on loans, this will, in effect, help lower prices all across the country. While there is not a direct correlation, the prime rate does play a role in inflation and vice versa. 

3. Credit Market

When the market as a whole is doing well, the Federal Reserve tends to raise the prime rate. When things go badly, it will also lower the rate to help out. When the market is going well, people go out and borrow money more frequently. They are not afraid of the prospects that the market has to offer. They feel confident in their employment situation and confident that they will be able to repay the loans. When the market is in a downswing, people tend to tighten up on their purse strings. They do not want to borrow money, and they do not want to spend what they have in savings. Lenders also tend to be more cautious in whom they give loans to because of their fear of default. In this situation, the Federal Reserve steps in and lowers the rate. This will have the long-term effect of getting people more involved in the market again and borrowing money. 

4. Strength of Financial Institutions

During very bad times in the market, lenders, like individuals, can go bankrupt. When banks and financial institutions start to become insolvent, the Federal Reserve tries to do its best to help. By lowering the prime rate, it can help lenders remain in business. It is in the nation's best interest that banks stay in business and keep lending money. Therefore, the Federal Reserve policy helps to keep things going as they should. 

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